Is Gold Losing Its Lustre?

Gold has long fascinated humankind. Who isn’t drawn to a shiny object? The allure of everyone’s favorite precious metal is evident throughout history as we’ve used it to store value, facilitate trade and fashion jewelry. In fact, gold has become the universal symbol for wealth.

For me, what’s most intriguing about gold is its price during major market events. Investors are usually lured by gold during times of uncertainty, and we saw a perfect example earlier this year when the price of gold jumped to over $1,350 USD per ounce in the wake of the Brexit decision, as the world wondered what the consequences of that vote might be.

What’s even more interesting is how gold has steadily declined in value since then, slipping to just under $1,130 USD per ounce on Thursday following the U.S. Federal Reserve’s (Fed) decision to hike interest rates.

Rates go up, gold goes down

The 0.25% increase to the federal funds rate target was widely expected, but the Fed’s hawkish projection for three more rate increases in 2017 did catch markets somewhat off guard as investors expected two. This led investors to sell equities, bonds and commodities like oil and gold.

As interest rates start to increase, so does the opportunity cost of holding gold compared to another type of income-producing investment. Therefore, investing in gold tends to become less attractive, especially with increased expectations for further rate hikes in the near future.

What does this mean for MD clients?

As of December 14th, allocation to gold in the MDPIM Canadian Equity Pool is 2.8%. We’ve decided to underweight gold relative to the S&P/TSX Composite Index benchmark by approximately 2.5%. To give you some greater context, during the rough start to 2016, we increased our allocation to gold from 2.4% in January to 5.8% in June. Later in the year as economic conditions improved and the Fed started to hint at a rate increase, we actively started decreasing our allocation.

As you can see, the cyclical nature of gold companies means that our allocation to them will change dynamically through time. This is in contrast to some companies, Canadian banks for example, where we will almost certainly have significant allocation to at most times.

When I look at gold companies, I typically find that they don’t have the quality characteristics to warrant long-term inclusion in our portfolios. They’re capital intensive and their projects rarely earn their cost of capital. In addition, the success of these companies is directly tied to the price of gold, which is often difficult to forecast and we’ve seen to fluctuate intensely.

For these reasons, we have been underweight to gold compared to industry averages over the past five years which has added strong positive performance compared to benchmark returns.

Simply put, there are better, shinier investment options elsewhere.

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